Fiscal Cliff, Asian Currency Wars, Buoys the Gold market

Gary Dorsch
Editor Global Money Trends magazine
Posted Nov 16, 2012

Texas Republican Ron Paul’s maverick crusade to “audit the Fed”, and to rein-in the “fourth branch” of the US-government, suffered a major blow in the wake of the November 6th elections that saw President Barack Obama prevailing over his Republican challenger Mitt Romney. Adding insult to injury, the Republican Party not only failed to secure a majority in the Senate, but it lost 2-seats. Mr Paul is the author of a bill to audit the clandestine activities of the Fed that passed the House by a 327-98 vote on July 25th, exceeding the two-thirds majority needed. Astoundingly, 89 Democrats joined 238 Republicans to approve it.

Many Republicans and some Democrats have criticized the Fed’s heavy handed activities in the marketplace, such as its multi-trillion dollar bailouts of the Wall Street banking Oligarchs, its massive monetization of the US-Treasury’s debt, through its radical “Quantitative Easing” (QE) scheme, and its basement of the purchasing power of the US-dollar. “The Fed has more power over the economy than anyone else in the country. Yet they are virtually unaccountable and the American people have very little idea what goes on behind closed doors at the Fed. The Fed operates in almost complete secrecy, and the whole idea that they can deal in trillions of dollars and that nobody is allowed to ask them a question is a moral hazard,” Mr Paul says. Dennis Kucinich, a Ohio Democrat agrees, “It’s time that we stood up to the Federal Reserve that right now acts like some kind of high, exalted priesthood, unaccountable to democracy.”

Commenting on the Nov 6th election results, Mr Paul lamented that the US-economy has already veered over the “Fiscal Cliff,” and that the nation is being transformed into a European style socialist welfare state. Mr Paul sees no chance of righting the ship in a country where too many people are already dependent upon $1-trillion of welfare assistance provided by states and the federal government. “We’re so far gone. We’re already over the cliff. We cannot get enough people in Congress in the next 5-to-10-years who will do wise things.”

Mr. Paul, who is retiring after 12-terms in the House, said “The people in the Midwest voted against Romney: ‘Oh, they have to be taken care of!’ So that vote was sort of like laughing at Greece. People do not want anything cut. They want all the bailouts to come. They want the Fed to keep printing the money. And they don’t believe that we’ve gone off the cliff or are close to going off the cliff. They think we can patch it over, that we can somehow come up with some magic solution. But you can’t have a budgetary solution if you don’t change what the role of government should be. As long as you think we have to police the world and run this welfare state, all we are going to argue about is who will get the loot,” Paul added.

During Mr Obama’s first term in office, US-federal spending jumped +18% to a record $3.52-trillion and spending has remained constant since then. There’s never been a serious effort to cutback on expenditures. As a result, the US-government has run deficits totaling $5.1-trillion over the past four years. There’s never been a string of budget deficits that even remotely approaches these staggering amounts; the last year of George W. Bush’s tenure, the previous record budget deficit was $459-billion. In order to finance these budget deficits, the White House has mostly relied upon the Federal Reserve and foreign central banks, to buy the lion’s share of the newly auctioned Treasury debt, and to a lesser extent, risk adverse investors fleeing the stock markets and Euro-zone bond markets, have been avid buyers.

Scaling the Fiscal Cliff - Now that the Nov 6th election is over, the vast majority of the US-public is learning for the first time about a dirty little secret, - it’s called the “Fiscal Cliff,” and it refers to a wicked combination of $500-billion of tax increases and $110-billion of spending cuts that will take effect next year, unless the Republicans in the House and the Obama White House can agree on ways to turn the cliff into the “Fiscal Hill.” Both political parties recognize the need to pare down the size of future budget deficits, in order to maintain the solvency of the country over the longer-term. There is no way to avoid the fiscal cliff, and if a recession ensues next year, both sides want to be able to win the public relations war, by pinning the blame for the fallout on the other political party.

The basic Republican framework for tackling the fiscal cliff calls for a reduction in spending on entitlements and capping social welfare programs. The fiscal cliff also provides tax reformers with a golden opportunity to overhaul the tax code, - by eliminating many of the deductions and credits, that reduce tax payments from individuals and corporations by about $1-trillion per year. Republican leaders are willing to eliminate many loopholes that disproportionately benefit the higher-income earners and scale back deductions for the business sector that earned $1.5-trillion in after-tax profits in the past 12-months. “In a good-faith effort to make progress on boosting the economy and government’s long-term solvency, Republicans like me are open to new revenue in exchange for meaningful reforms to the entitlement programs,” said Senate Minority Leader Mitch McConnell (R-Ky.) on Nov 13th.

The War on the Ultra-Wealthy - Mr Obama owes a big debt of gratitude to Fed chief Ben Bernanke, who helped to engineer his re-election, by masterminding a improbable +3,000-point rally in the Dow Jones Industrials from the Oct 4th, 2011 low of 10,500, to above 13,500 in Sept ’12. The rally helped to boost US-consumer confidence, and lifted Obama’s approval rating with a sizeable segment of the voting population. However, now that Obama has been re-elected to a second term, his emphasis is already shifting 180-degrees, - from boosting the fortunes of the Ultra-wealthy, - that’s heavily tied-up in the artificially inflated - stock market, - to waging war on the Ultra-wealthy, by aiming to hike their tax rates on dividends, capital gains, and ordinary income. Such a move is expected to raise about $80-billion in extra revenues for the US Treasury, according to some estimates.

Mr Obama will begin talks on the Fiscal Cliff with a proposal to raise $1.6-trillion in new tax revenue, with 80% of the tax increases paid by high-income earners, and 20% from Corporate America. That means the top-1% would pay $121,000 more in taxes each year. The top 20% of income earners would pay an average $14,000 more each year. That’s important, because the top-1% of the wealthiest Americans own 38% of the stocks traded on the NYSE and Nasdaq. The next 9% tier of wealthy investors control 44% of the total shares. Jacking up taxes on capital gains and dividends and eliminating tax loopholes for Corporate America has spooked the top-10% richest investors, into dumping their stocks before year end.

“When it comes to the top-2%, what I am not going to do is extend further a tax cut for folks who don’t need it which would cost close to a $1-trillion. The math does not work, in some proposals to raise taxes on the wealthy by just closing tax loopholes,” Obama said on Nov 14th. Obama said he is “very eager” to reform the tax code, (ie eliminate many of the tax loopholes for Corporate America), and said entitlements like Medicare and Social Security need a “serious look as part of a deficit deal.” While there is no sympathy for the Ultra-wealthy, the broader US-economy would be at risk of a renewed downturn, because tackling the fiscal cliff would require some degree of “fiscal austerity,” just like in recession ravaged Europe.

At the end of the day, no matter what amount of austerity is agreed upon, the US-federal government is still expected to run a budget deficit of $700-billion or more. In order to finance the shortfall, traders can expect the Obama White House to call upon the political puppets that sit at the Federal Reserve, to create hundreds of billions of electronically printed US-dollars through its Infinity QE-3 program. That message has already been transmitted to the Fed. At the Fed’s October meeting, a number of Fed officials spoke about the need to step-up Treasury bond purchases next year. Fed deputy Janet Yellen said that the federal funds rate could stay locked near zero-percent until early 2016 in order to help keep the US-Treasury’s financing costs as low as possible. Through the Fed’s totalitarian control of credit, - financing the US Treasury can be done cheaply in spite of the mushrooming of the national debt, - until an inflection point is reached, where hyper-inflation begins to take-off.

The Fed slashed the overnight federal funds rate to near zero-percent in December 2008 and has pumped $2.3-trillion of freshly printed dollars into the money markets. In turn, investors seeking a safe haven from the debasement of paper money, turned to Gold, - bidding-up the price of the yellow metal from $700 /oz four years ago, to above $1,700 /oz today. The price of Silver nearly quadrupled from $9 /oz to above $32 /oz today. Gold Bugs and Silver Bulls alike can breathe a big sigh of relief, knowing that Bernanke will have his fingers on the printing press in the year ahead. Since Sept 13th, the Fed has begun printing $40-billion per month, an open-ended scheme, with no pre-determined timeline. Mrs Yellen, an addicted money printer, advocates a “highly accommodative policy,” even “if inflation overshoots the Fed’s 2% inflation target objective for several years,” she said.

Many investors have turned to exchange traded funds (ETF’s), listed on the stock exchanges which issue securities backed by physical holdings of Gold. Demand for these funds has increased five-fold since July 2006. Collectively, they hold 75-million ounces in the vaults, - that’s up from 14-million ounces in July of 2006. Gold is a highly liquid vehicle that can preserve an investor’s purchasing power over the longer-term. In fact, the central banks that are the world’s most notorious money printers were net buyers of 252-tons of Gold in the first half of 2012, after purchasing 456-tons in the year before.

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Mr Dorsch worked on the trading floor of the Chicago Mercantile Exchange for nine years as the chief Financial Futures Analyst for three clearing firms, Oppenheimer Rouse Futures Inc, GH Miller and Company, and a commodity fund at the LNS Financial Group. As a transactional broker for Charles Schwab's Global Investment Services department, Mr Dorsch handled thousands of customer trades in 45 stock exchanges around the world, including Australia, Canada, Japan, Hong Kong, the Euro zone, London, Toronto, South Africa, Mexico, and New Zealand, and Canadian oil trusts, ADRs and Exchange Traded Funds.

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